Formations, Reorganizations, and Liquidations Involving Insolvent Corporations
New York State Bar Association
Tax Notes, Vol. 110, No. 7, February 20, 2006
This report comments on proposed Treasury regulations issued under sections 332, 351, and 368, which provide rules regarding formations, reorganizations, and liquidations involving insolvent corporations. The authors commend the IRS and Treasury for focusing on the issues underlying the proposed regulations and for undertaking this project with a view to providing greater clarity in an area where the law is particularly unclear.
The authors generally support the conclusion in the proposed regulations that an upstream restructuring of an insolvent subsidiary cannot qualify as tax-free under section 332 or section 368. The report offers some observations and considerations regarding interactions with the consolidated return regulations that are created by the proposed regulations, as well as issues that arise when a subsidiary corporation transfers its assets to the parent corporation with respect to one class of stock while the other class receives nothing.
They also support the proposed modifications to the continuity of interest (COI) provisions and offer recommendations to improve specific aspects of the COI provisions, including: (1) priority claims that receive special treatment under the Bankruptcy Code should also receive special treatment for COI purposes; (2) the final regulations should contain an example demonstrating the disproportionate receipt of acquiring corporation stock and other property among the senior class of creditors; (3) the IRS and Treasury should clarify the circumstances in which the receipt of stock by a creditor or shareholder will be disregarded for COI purposes; (4) amounts received on partially secured creditor claims without a formal allocation between the bifurcated portions of the claim should be allocated based on the regulations under section 108(e); and (5) pretransaction payments should affect COI only if made in connection with the transaction.
The authors believe that the COI requirement, as modified by the proposed regulations, addresses the policy concerns expressed in the proposed regulations regarding reorganizations. In light of those policy considerations and the existing authorities, they recommend that the IRS and Treasury eliminate the net value requirement for reorganizations from the proposed regulations and clarify that no exchange requirement will be imposed on sideways reorganizations outside the bankruptcy context.
They also recommend that the net value requirement in the proposed regulations be modified to require only that the transferee must issue stock that has value in exchange for the property transferred in a putative section 351 transfer. Value for that purpose would be defined as the value that a third-party willing buyer would pay for the stock, instead of the corporation's net asset value (as in the proposed regulations).
Finally, the authors agree that if a net value requirement or modified COI provisions are adopted, liabilities should be broadly defined for purposes of determining net value and a definition of liability similar to the definition of obligation in Treas. reg. section 1.752-1(a)(4)(ii) should be adopted. They recommend generally that all liabilities should be valued using a fair market value approach because it offers the best economic determination of whether net value has been surrendered and received. In recognition that such an approach creates numerous and difficult valuations, they further recommend that the IRS and Treasury consider including some safe harbors for valuation purposes.
Accepted Paper Series
Date posted: February 18, 2006
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